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Case Study: Applying for pension protection is not always the best idea

Deciding which type of pension protection to apply for can be more complicated than just how much has been accumulated in the fund.

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The problem: A client who is a long-standing member of a defined benefit pension scheme is considering applying for fixed or personal protection in advance of April’s reduction in the lifetime allowance from £1.5m to £1.25m. What factors should be taken into account when deciding which, if any, type of protection is the most appropriate?

The solution: Peter is one of the lucky few who have been in a good non-contributory defined benefit pension scheme for over 20 years and so has built up a significant pension. He had never really told anyone that he had been close to opting out of the scheme many years ago. Now, twenty years of inertia later, he was pleased that he had not got around to leaving the scheme.

Peter has just received a benefit statement from the scheme and is a bit concerned. His intention was to consider retiring at age 60, which was in just a couple of years’ time, but the normal retirement age under the scheme was 65.

He has also made £300 per month contributions into an AVC scheme.

Peter is married for a second time and his wife was younger than him. Together they have a couple of school-age children and a reasonable-size mortgage.

His family health history is poor and he had a minor heart attack two years ago, although he had fully recovered now.

Peter has been to visit his pension adviser to discuss pension planning. It appeared that his current pension benefit was valued at about £1.4m (20 times his prospective pension, plus his lump sum) as his employer paid about 12 per cent of his current remuneration of £150,000 into the scheme.

In addition, the scheme offered a spouse’s pension which was four times salary, with death in service benefits and the possibility of an ill health pension based on prospective scheme service. 

He has heard of fixed protection 2014, which would allow him to protect £1.5m of pension assets but is not happy that he would have to cease paying contributions and probably have to opt out of the pension scheme to avoid the extra accrual invalidating his fixed protection.

He knows he is due a couple of pay rises and also feels that, with the current inflation figure falling, the CPI limit on relevant benefit accrual could easily be breached.

Taking his adviser’s guidance, Peter has spoken to his employer and asked whether it would be prepared to pay him the money it contributs to his pension scheme in some other form of remuneration. The answer he got was that this would not be possible as it was not company policy.

His adviser has explained the concept of individual protection to him, which he understands would give someone with pension savings worth between £1.25m and £1.5m a personal lifetime allowance of the amount as valued on 5 April 2014.

The main difference between fixed and individual protection was that with individual protection, he would be able to continue saving without limit into the scheme but with the LTA tax charge applying to the excess over the personal LTA as set at 5 April 2014 of 25 per cent on money drawn as a pension, and 55 per cent on a lump sum. So his current pension value of £1.4m would be his new personal LTA.

This is obviously not quite as good as the £1.5m that could be protected by fixed protection but the idea of having to opt-out of his generous DB scheme is even less attractive to him. Peter’s health situation and his family circumstances meant that the ancillary death and health benefits were of a greater value to him, particularly for the next couple of years before retirement.

Two other things that he has been told by his pension adviser are:

  • If he did opt for fixed protection then he would have to watch out for auto enrolment, as any accidental auto enrolment could invalidate his fixed protection.
  • It would be advisable to stop his AVCs and perhaps redirect them into a different investment plan to avoid the tax charge on his money.

Mike Morrison is head of platform technical at AJ Bell

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